Technical traders use the Moving Average Convergence Divergence (MACD) indicator to identify trends and momentum in market activity. The MACD, especially when looked at alongside price trend data, can be a powerful tool to determine whether a stock is building momentum or headed for a possible reversal in trend. Like all technical indicators, it doesn’t work all the time, but it is successful enough that it is a staple for many traders.

MACD Basics

Before looking at an example, let’s quickly cover the basics of this indicator. The Moving Average Convergence Divergence indicator generally uses the 12-period exponential moving average (EMA) and the 26-period EMA. The MACD is calculated by subtracting the 26-period EMA from the 12-period EMA. After getting the results of this calculation, a nine-period EMA of the moving average convergence divergence is plotted. This nine-period EMA of the MACD is known as the signal line.

The MACD can show bullish or bearish divergence. A bullish divergence occurs when the MACD is making higher highs while the stock price is making lower highs.

Moving Average Convergence Divergence in Action

Let’s take a look at an example of a bullish divergence.

Source: TradingView

In this daily chart on NVIDIA Corp. (NVDA), notice how NVDA was making lower highs, but found some support around the $96 area. Looking at the MACD, as annotated, the indicator is making higher lows and higher highs. This is considered a bullish divergence, and an indication that the stock could reverse. You can see for yourself how that trade would have worked out, if you went long based off of this pattern.

Final Thoughts on MACD

As traders, we must always do our homework. Go out and find stocks that exhibit bullish and bearish divergences. For the bearish divergence, look for higher highs in price action, and lower highs in the MACD; the opposite is true for bullish divergence. Again, this pattern doesn’t always work out as expected, so manage your risk properly and get out if there is no visible confirmation of the signal you spot in the charts.

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Jason Bond runs JasonBondTraining.com and is a swing trader of small-cap stocks.

Author: Jason Bond

Jason taught himself to trade while working as a full-time gym teacher; his trading profits grew eventually allowed him to free himself of over $250,000 in student loans!

Now a multimillionaire and a highly skilled trader and trading coach, Over 30,000 people credit Jason with teaching them how to trade and find profitable trades. Jason specializes in both swing trades and in selling options using spread trades, which balance the risk of selling options. Jason is Co-Founder of RagingBull.com and the RagingBull.com Foundation which donates trading profits to charity. So far the foundation donated over $600,000 to charity.

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